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https://www.barrons.com/articles/chinas-twisted-logic-1422321543

Up & Down Asia

Beijing’s Twisted Logic

By

Wayne Arnold

Updated Jan. 27, 2015 4:28 a.m. ET

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Science never ceases to deliver solutions to mankind’s greatest riddles, whether it’s how to land on a comet or stop a nosebleed by stuffing cured pork up your snout. The latest breakthrough is how to unboil an egg. Researchers in California have figured how to use one of the main ingredients in urine to reverse the tangling of proteins that occurs when an egg is boiled.

This may be good news for China, which has been trying since 2009 to unboil its economy. Yet it remains perched on a Great Wall of credit, like Humpty Dumpty, with officials and economists applying to China a logic reminiscent of that Alice encountered when she met Humpty in “Through the Looking Glass:” If China’s credit bubble ever did collapse – which there’s no chance of – but if it did – the government has promised to send all its horses and all its men and pick China’s economy up again.

An even curiouser pronouncement came in response to last week’s move by the European Central Bank to print 60 billion euros a month to buy government and corporate bonds. In a news conference, People’s Bank of China Vice Governor Pan Gongsheng said Friday that the flood of new euros was likely to boost China’s exports to Europe and put downward pressure on China’s yuan.

Boost exports and push down the yuan? It is a most provoking thing when a person doesn’t know a cravat from a belt.

For starters, printing 60 billion euros a month is a sure-fired way to weaken the value of the euro against any currency whose supply isn’t increasing at an equivalent rate.

A weaker euro also makes imports more expensive for europeans. Hence, there is a direct correlation between the strength of the euro relative to China’s yuan and the growth rate of China’s exports to Europe. The only way the ECB’s quantitative easing would boost imports from China is if it succeeds in reviving European growth, which for reasons discussed in yesterday’s column, is unlikely in the near future.

The printing of euros is thus likely to hurt China’s exports to Europe and would push up the yuan relative to the euro but for one thing: the exchange rate of the yuan is not freely floating, but fixed by the People’s Bank of China. Traders violate this peg at their peril, for the PBoC has used money-printing for years to buy up nearly $4 trillion dollars to keep the yuan from rising. It can now sell those dollars if necessary to keep the yuan from falling.

In fact, it has been. With its own economy weakening, the property market falling and Beijing declaring open season on official corruption, money has been seeping out of China for months. So despite rising exports China’s foreign-exchange reserves have dropped 3.5% since June, to $3.84 trillion. The PBoC isn’t mounting a very determined defense, however. Despite selling off some of its dollar hoard, it has nudged the yuan 2% lower against the U.S. dollar since late June.

Some analysts believe the PBoC isn’t eager to see the yuan fall too far, too fast. Doing so might reduce the currency’s popularity overseas, where China would like to see the yuan replace the dollar in global trade. And a falling yuan could intensify the rush of cash out of China and hurt Chinese companies that borrowed cheap U.S. dollars offshore. According to the Bank for International Settlements, foreign bank lending to borrowers in China climbed 30% in the third quarter of 2014 to $1.3 trillion.

But the market believes the yuan will move even lower: yuan traded offshore have dropped 2.3% in the past three months and the gap between the official rate and what investors will pay for a year from now is growing. Citigroup predicts the yuan will fall another 1.4% in the next year, to 6.32 to the dollar, from roughly 6.23 now.

A weaker yuan would make China’s exports cheaper overseas, helping China maintain market share against Japan, whose central bank is printing up to 80 trillion yen a year to boost exports. It would also help shore up exports to Europe, China’s second-largest export market after the United States.

Pan may have simply scrambled the order of events when he suggested a weak euro would help China’s exports and weaken the yuan. It’s surely the other way around: China will weaken the yuan and support exports to Europe.

But who are we to question the PBoC? When it uses a policy, it means just what it chooses it to mean – neither more nor less.

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